The associate company of Air China (00753 HK, “the Company”), Cathay Pacific Airways Limited (00293HK, “Cathay Pacific”), announced a recapitalization plan of HKD39 billion. The recapitalization plan involvesissuing 1) preference shares and warrants, 2) a 7:11 rights issue and 3) a bridge loan.
Air China will only be involved in the rights issue and the shareholding dilution is not material. Air China willhave the option to subscribe 750.76 million of Cathay Pacific’s shares, which approximates to HKD3,514 million(equivalent to approximately RMB3,162 million). Assuming the preference shares holder exercise all warrants, AirChina shareholdings of Cathay Pacific will be diluted from 29.99% to 28.17%. The impact is limited and CathayPacific will remain as an associates of the Company and there will be no changes in accounting treatment.
The weakening of Cathay Pacific will drag Air China. Despite limited impact from the recapitalization plan ofCathay Pacific, the operational weakness of Cathay Pacific will hurt Air China. The outbreak of COVID-19 hasimpacted the global travel industry, but some recovery trend has been seen for those that have a local presence.The China big 3 carriers, including Air China, are relatively better-off due to their strong exposures in domestic. In2019, 66.1% of Air China's revenue was generated by domestic routes with the highest domestic passenger yield.Therefore, the early resumption of China’s economy has helped Chinese airlines recover ahead of global peers,albeit in a gradual manner. We expect Cathay Pacific will have a longer recovery period as internationaltravel/transit is still its key market and RPK on mainland China only represented 6.1% of the total in 2019. Weexpect international travel will only gradually resume in around 3Q-4Q20, with flight restrictions and socialdistancing measures to be implemented.
Investment suggestion: Earlier this month, Beijing again lowered its public health emergency response from thesecond level to the third level starting from 6th June 2020. Further, China will now allow foreign airlines to operateflights to/from China, despite still needing to adhere to the 5-1 policy (1 Country 1 Route and 1 Flight per week).This indicates that China continues to open up its economy and is among the fastest among other countries. Weexpect that the worst time has passed, and recovery is underway. Currently, we have an “Accumulate” ratingfor Air China (00753 HK) with TP of HK$5.60, which represents 0.8x 2020 PER.